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From sub-primes to anarchy: it isn’t such a leap

August 31, 2007

“Bernanke maintained that it is not the Fed’s responsibility to bail out borrowers who took on risky loans or the financial institutions that made them, saying that it would not be ‘appropriate…to protect lenders and investors from the consequences of their financial decisions.’

“Nonetheless, he did say that ‘developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.'” (Source: “Fed Ready to Act”)

I’ve been waiting two years for the sub-prime meltdown to come into common parlance, and it has arrived. I’ve watched, fascinated, wondering whether the models in the animated ads on Yahoo! were going to jump out their windows when their $510,000 ARMs at $1,200 a month bumped up. But the resilient models now have gigs on insurance ads.

Other people aren’t so resilient, but rely on Helicopter Ben to save them– without directly paying off their homes–that of course, would be “moral hazard,” and encourage reckless investing.

Greenspan warned of investors’ “irrational exuberance” in the previous decade, but heck, their exuberance was perfectly rational. Why not invest if the Fed will practically guarantee controlled losses?

What I don’t see anyone calling this is anarchy. The A-word just isn’t coming up. But what else is it if the least responsible people are essentially making policy?

The Fed is operating as clean-up crew, while irresponsible borrowers and investors are setting policy by behavior. The Fed is simply reacting, invoking situational policy because it deems the damage too big not to.

The Fed’s safety net protects everyone from the consequences of inherent market risks, so the booty really goes to those driving up the consequences–the least responsible. The Fed is mopping the bloody streets with a bloody sponge so no one gets hurt. It’s soft anarchy.

Just because incredibly foolish lending opportunities are presented doesn’t mean people should buy over their heads. But they do, and they have been, and now we are seeing the fruits of their unfunded opportunism and correctly referring to the crash as a crisis. What was behind their optimism?

Moral hazard, of course. Moral hazard in this case means the reduction of risk based on sure rescue response by the government. Greenspan sounded the moral hazard alarm, warning of the recklessness that bailouts would encourage. But when things got too tough for too many, well, that’s the hazard–they got help. The help becomes a factor in future behavior–there will always be help, so why be responsible? Investors, borrowers, and lenders had seen it before. The Fed would cushion their fall.

The Fed’s predictable behavior is an established factor in general public optimism. Individuals may not perceive this directly, but they are swung by the trend pushed by those who do. They go for the gold as though nothing could happen. Who can blame them?

So what Bernanke is saying here is that it’s bad for business if the Fed bails people out. But if business gets too bad for too many, the Fed needs to bail people out. Again, this places the least responsible people in the economy’s cockpit. The people live to spend; the Fed lives to save. The situation, not principle, pilots the whole economy to doom, and the Fed throws the people’s money back at it. Then everyone replays the same roles.

Help is coming. Borrowers who would not have qualified for FHA loans before and were driven to sub-primes, now suddenly do, under a new Bush plan. This is not a bailout, we are assured; no, a bailout would “only aggravate the problem.” This is an opportunity to refinance, for people who were formerly unqualified. Nothing has changed but the rules.

Imagine kids trashing a house as a party activity, and the parents just appear and clean up and go back to reading the paper upstairs. Or imagine a casino that gives you money when you’ve lost everything, to enable you to keep playing. Replaying moral hazard, and then doing clean-up duty anyway because the damage is “too big and too broad not to” is anarchy because no one’s in charge.

The economy still looks free because everyone is free to fail. But failure is mitigated by the knowledge that the government will respond and refill investors’ tills, in one way or another. Where failure is mitigated, freedom is mitigated.

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4 Comments
  1. August 31, 2007 9:28 am

    Umph. The CNN article doesn’t mention two other aspects of the Bush non-bailout plan: eliminate the FHA 3% down payment requirement and increase the insured default amount to $417,000.

    http://online.wsj.com/article_email/SB118851742988914064-lMyQjAxMDE3ODM4MTUzMTE3Wj.html

    Pretty soon anybody who doesn’t have 3% down can finance beyond his dreams and have it government guaranteed. It will do wonders for the hedge funds, who are the ones really getting bailed out.

  2. August 31, 2007 9:44 am

    Ah yes, $417k: it is the very model of the number of the jumbo loan encumber.

  3. September 1, 2007 9:38 am

    Alan Greenspan is my uncle.

  4. September 1, 2007 10:40 am

    Well, isn’t the money all metaphorical anyway?

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